Escalation Clause: What Is It And How Does It Work?

Creating a strong purchase offer is critical when you’ve found a home you want to buy. Essentially, you want to tell the seller you’re both qualified and serious about buying the home. In some cases, you may even write an escalation clause into your offer.

What Is an Escalation Clause?

An escalation clause is a special provision you can add to a purchase offer. The clause automatically increases your purchase price by a certain amount above other offers until it reaches the maximum price you’re willing to pay for the home.

The escalation clause, sometimes known as an escalator, only goes into effect when the seller receives more than one offer. It may include the following parts:

• Initial offer: The purchase price you offer on the home.
• Proof of a bona fide offer: A request to see proof the seller has another purchase offer on the home.
• Escalation amount: The amount your offer will increase over competing higher offers. You can choose any amount.
• Number of escalations: The number of times you’re willing to escalate the price.
• Price cap: The maximum price you’re willing to pay for the home.

How Does an Escalation Clause Work?

In a standard transaction with no escalation clause, you can make an offer on a home—but you lose the opportunity to buy if someone else offers a higher price. An escalation clause gives you the chance to compete for the home. It activates when the seller receives at least one offer that matches or exceeds your bid. Your offer amount then increases by the escalation amount you set until you reach your price cap.

If a competing buyer also includes an escalation clause in their offer, the offer price on the home continues to increase until one of the buyers’ price caps has been reached.

Escalation Clause Example

Let’s say you’re trying to buy a home in a seller’s market, so you include an escalation clause in your purchase offer. Your initial offer is $400,000, the escalation amount is $5,000 and the maximum price you’re willing to pay is $415,000. Another buyer submits an offer for $403,000. This triggers the escalation clause, automatically increasing your offer to $408,000.

One of two scenarios can then take place:

• If the competing buyer doesn’t have an escalation clause, you’ll win the bid because your offer is now higher—$408,000 versus $403,000.
• If the competing buyer has an escalation clause, the offer price would continue to increase until it hits a price cap. Let’s say the competing buyer included an escalator of $3,000 with a maximum price of $412,000. In this case, you’d still win the bid because your price cap ($415,000) is higher.

How and When To Use an Escalation Clause

Your real estate agent can help you include the escalation clause in your purchase offer. You’ll need to tell your agent how much you’re willing to spend overall and the amount you want to raise the price with each escalation.

Working with an experienced real estate agent helps because they’ll know local laws surrounding escalation clauses and can guide you through the process. A real estate attorney may also be able to help you review the language in the clause.

An escalator can be a good option in a market where inventory is tight and a home might receive multiple offers. Your agent might not know the highest offer, but they don’t want you to overpay. The escalation clause allows you to raise your offer in small increments.

Knowing your limits up front is a good idea—your price cap generally shouldn’t exceed the amount you can afford. A mortgage preapproval letter can help you define this limit.

Pros and Cons of Escalation Clauses

An escalation clause may help you secure the home you want to buy, but it also comes with some downsides to consider.

Pros

• May help you win a bidding war. You gain a competitive edge by being willing to outbid other potential buyers. This can help you win a bidding war in a hot housing market.
• Streamlines the bidding process. You’ll get ahead of competing bids without constantly revising your offer price.
• Offers some transparency. You’ll provide your maximum offer up front, eliminating any guesswork for the seller.

Cons

• Removes the chance to negotiate. The escalation clause reveals your highest price, which may remove some of your bargaining power.
• Adds risk of overpaying. Being caught up in a bidding war could lead to paying more for a home than it’s worth.
• Potential for an appraisal gap. If there’s a gap between the final sales price and the appraised value, you’ll need to pay it out of pocket.

Who Should Use an Escalation Clause?

In some situations, an escalation clause can help your offer get accepted. Here’s who should use this option:

• Individuals buying a home within a competitive seller’s market. Homes may receive dozens of offers, so the clause ensures yours won’t be rejected immediately when there’s a higher bid.
• Buyers who want their offer to stand out. The clause tells the seller you’re serious about buying the home.
• Buyers who can afford to pay the maximum price listed in the clause. You should be confident you can pay for the maximum price cap, and the monthly payment should fit into your budget.

However, you may want to avoid an escalation clause in some cases. Using one may not be a good idea if you can’t afford the maximum price limit, and some sellers may reject an escalation clause altogether. Also, it typically doesn’t make sense to use one if you’re in a buyer’s market because escalation clauses only trigger when competing offers exist.